18 December 2018

Global markets plunge on weak economic data from China and Europe

South Africa

The JSE weakened amid comprehensive losses on Friday following a sharp 3% decline by Tencent, however, the local bourse was on track to close the week firmer. At the close of business, both the All Share and the Top 40 traded in the red.

United States

US equities plunged on Friday as less-than-inspiring economic data from China and Europe aggravated concerns over slowing global growth and added to apprehensions over the US-China trade spat. The Dow lost over 248 points and the S&P 500 ended 0.98% in the red.

Europe

European stocks took a knock for a second consecutive day on Friday, after poor Chinese data fuelled concerns over the health of the world’s second-largest economy and backlash from China’s on-going trade dispute with the US. At close of business the pound rose 0.97%.

Hong Kong

Hong Kong stocks plunged on Friday amid concerns over the deterioration of the world’s second largest economy after China posted poor consumer and factory figures. The Hang Seng closed 1.84% in the red.

Japan

Poorly performing large-cap stocks led to the decline in Japan’s Nikkei on Friday, following flat Dow Jones futures and worrisome economic indicators from Asia. The Nikkei share average plunged 2.09% ending the day at 21 359.50 points.

Rand

The local currency weakened against the dollar on Friday afternoon, on fears of decelerating global growth, while the markets digested poor economic data registered by China and France. At 17h00 the rand traded R14.44 against the dollar.

Precious metals

Gold prices fell to a one-week low on Friday afternoon amid a strong dollar environment, registering the biggest weekly drop in five months ahead of the US Fed’s interest rate decision expected this week. At the close of business spot gold was down 0.50%.

Oil

Oil prices dropped on Friday after China cited reduced fuel demand for its poor economic performance, although sentiment was somewhat lifted by Opec’s agreement to reduce excess supply to help the oil price. At 18h00 benchmark Brent crude was trading at $60.75 a barrel.

Highlights

The largest contributor to Naspers’s net asset value (NAV) remains its investment in Tencent, which is separately listed on the Hang Seng stock exchange.

Tencent was a key contributor to the overall performance and remains the dominant factor in investment returns given its size in the portfolio.

We remain concerned over the stretched valuation of Tencent and we feel that regulatory changes and slower advertising growth due to a difficult Chinese macroeconomic environment, are evolving into significant headwinds.

This might impact earnings from both the gaming and the advertising operations, which are the drivers of sustained earnings growth. Slower growth in these divisions is likely to translate into earnings growth below current market estimates and can place further pressure on the share price.

Our estimation shows that Naspers is currently trading at a 7% discount to our sum of the parts (SOTP) valuation.

Reduced cash burn of internet assets, improved profitability as scale builds, lower development and marketing spend, as well as corporate actions (including the unbundling of the video entertainment division) could lead to a narrowing in the discount.

While the group’s balance sheet has improved after selling investments in Tencent (partially) and Flipkart (completely), potential value-destruction acquisitions remain a concern.

Naspers has significant forex exposure, which could impact the group’s valuation significantly.

Emerging market risk aversion and changes in venture capital’s risk appetite, could have a material impact on the valuation of investments.

Highlights

Given the evolving nature of many of the group’s businesses, determining sustainable growth accurately remains a challenge. With high growth already been priced into the valuation we feel the share is fairly-valued.

Forecasting risk, however, remains high due to regulatory changes and slower advertising growth caused mainly by a challenging macroeconomic environment evolving into a significant headwind.

The group’s leadership position in social media platforms (WeChat and QQ) provides it with significant potential to monetise ad inventory, optimised by data and analytics gathering across its multiple platforms. This should allow it to push more relevant and personalised content, which should translate into higher ad conversion and therefore ad pricing.

The recently announced reorganisation of the company intends to integrate product teams and data better and to improve analytics to deliver personalised content and ads to users. Tencent's advertising penetration is still lagging behind its peers; in the short term, improved adoption is likely to be constrained by a more difficult macroenvironment and the communicated reorganisation.

Sentiment towards China's mobile games industry is likely to remain weak given poor monetisation of survival games and the uncertain regulatory environment. New initiatives such as tournament games and overseas expansion are only likely to contribute in the medium term.

Highlights

We recommend an underweight position in Woolworths as we feel divisions face material, structural and cyclical challenges, which, combined with a strained balance sheet significantly increase their risk profile.

The food operation is the most attractive division; consistently producing sector leading volume growth and market-share gains.

But, we are concerned about the impact constrained consumers will have on medium-term results and the division’s ability to drive efficiency gains further as margins are already on a high base and ahead of management’s medium-term targets.

While we expect results to remain solid, it is unlikely for food to stay the engine for growth, as it has been in the recent past, with the division contributing close to 40% of earnings.

Local clothing and general merchandise is suffering from a cyclical downturn and achieved three-year CAGR (compound annual growth rate) of around 3% while margins declined by a quarter as the division struggled with a poor fashion offering, which assisted international players to gain market shares.

The David Jones operations remain a primary concern as structural challenges in the retail environment are raising fears around the sustainability of its current business model.